The Current State of Integrated Payments: A Convergence of Software User Experience and Electronic Payments

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1 The Current State of Integrated Payments: A Convergence of Software User Experience and Electronic Payments PETER USELMAN November 2017

2 Introduction: A Brief History of Payments When plastic cards were first introduced as a method of payment, cardholders were tasked to ensure merchants supported the bank who provided them their particular card. The payment industry has come a long way since then, and now, the power of a Visa or MasterCard logo can t be understated; there s now ubiquitous acceptance and brand confidence at over eight million US locations alone. Over that time, merchants transitioned their payment acceptance methods from paper sales slips and manual imprinting to more technology driven acceptance methods, such as a counter-top swipe terminal or other hardware-based products. As recently as the last decade, card payment acceptance remained a separate process from other systems; it was both traditional and institutional. Technology is driving the current market state from this standalone nature to a more holistic and embedded experience. As merchants adapt more vertical software solutions to run their business, they are looking to identify additional ways to not only gain stronger efficiencies, but tighter control over internal processes and enhance their customer s experience from checkout experience, payment remittance and everything in-between. Merchants, or the accepting business party of a payment, have been driving this technological shift from software companies. Software companies, commonly referred to in the payment industry as Independent Software Vendors (ISVs), continue to evaluate their own business cases to either add or improve their payment products. While satisfying their clients demands for a more integrated process and better user experience is a primary aspect, other factors have emerged. Revenue growth through payment monetization has been a benefit of supporting more payment development and utilization by ISVs. Many ISVs are looking for a way to develop greater product differentiation over their competitors and see payments as an angle to develop a competitive advantage. To many software companies, their ongoing support experience is vital to their operations and they see payments as a way to create stickier customer relationships and as a retention tool. However you view the current state and the contributing factors, it s easy to draw the conclusion that there is a clear convergence happening between the software and payment industries. Contextual and integrated payments are here to stay for the foreseeable future. This shift has led to varying approaches and mindsets as to how to blend the software and payment experience. The approaches to the implementation of payments with interactions with their clients varies. The goal of this white paper is to present a clear overview of how payment processors and software companies are working together in this current state, primarily: An overview of approaches and models that have evolved as result of this convergence Reviewing specific aspects of each approach to help provide further definition and context Understanding which factors drive ISVs to a certain approach Positioning of where the best opportunities currently exist for ISVs today Software companies, commonly referred to in the payment industry as Independent Software Vendors (ISVs), continue to evaluate their own business cases to either add or improve their payment products. 2

3 The Five Approaches to Contextual or Integrated Payments Whether your software platform serves merchants in the B2C or B2B segments or is creating a new P2P Marketplace opportunity, software companies are finding more and more ways to incorporate and automate payment processing within their solutions. Roughly 51% of ISVs have enabled payments to be made directly as a feature within their product-set, per a 2016 study by First Annapolis Consulting Group. With that adoption rate on the rise, many ISVs are taking an opportunity to reevaluate the role payments could play in their platform. Part of the reevaluation is to better explore the spectrum of options that payments can play today. In the current environment of integrated payments, we see ISVs interacting with payment providers to incorporate payments within their software in one of five ways. Each approach varies based on a number of factors, primarily related to user experiences of the merchant, and the roles that both the ISV and payment processor manage. In ISV research First Annapolis completed in July 2016, half of ISVs utilize integrated payments. Do you currently integrate payments into your solution set? N % No 51% Yes Channels for which your solution accepts payments N-158 In 2016 research, of the ISVs that had integrated payments into their solutions, half received no compensation for referrals. Does your payments provider compensate you for referrals? What is the structure of your compensation? N % No Compensation Source: First Annapolis Consulting primary research 58% Multichannel 7% Other 15% One Time Referral Fee 29% Ongoing % of Revenue 42% In-store AGNOSTIC MODEL: Some ISVs have taken the approach of being payment provider agnostic, or providing their clients with the ability to use any provider within their platform. ISVs incorporate this model by enabling both payment functionality and flexibility. Many ISVs have written product interfaces to an industry agnostic payment gateway, which is software that communicates directly with a host system payment processor. This option essentially provides customers of an ISV the freedom to partner with any payment provider they wish by plugging in to a pre-integration. In this model, the ISV partner does not benefit from the stickiness nor do they receive any compensation from the payment providers. REFERRAL MODEL: ISVs that wish to take a slightly more strategic approach to adding payments develop relationships with payment providers themselves. By adding one or multiple preferred partners, an ISV can start to develop a revenue stream off of payments and have more input into the sales and support experience of their clients. ISVs that operate in this environment still allow flexibility as their partner is preferred in nature, not required. SHARED-SALES MODEL: Other ISVs take a more aggressive partnership approach and enable their software to interface to one payment processor exclusively. This approach allows for greater monetization and increased control over both merchant sales and ongoing support experience. The conjoined efforts of both the payment processor and ISV remain highly visible and united throughout the relationship. WHITE-LABEL MODEL: Just as some ISVs offer the ability to white label their own software solutions, the same opportunity exists for ISVs to function in many ways like a payments provider. By taking a payment provider s solution and applying their own branding, processes, and support models, they act as a proxy payment processor. This approach enables a software company to take on much of the direction and control without the concerns around credit underwriting or regulatory compliance. ISO MODEL: An ISO, or an Independent Sales Organization, is a payment industry term used to describe an organization that is directly responsible for credit underwriting and boarding clients onto a specific processing platform. ISOs carry regulatory requirements and are also sponsored into the industry by an Acquiring Bank, or an institution that serves as their direct interface to the Federal Reserve for fund movement. Additionally, emerging trends for marketplace applications, or platforms serving many small micro-merchants, exist in the form of Payment Facilitation. PayFac, another term that is used to describe a software company acting in the capacity as an 3

4 ISO, is a model to aggregate transaction volume to manage costs and simplify implementation of many small users. Whether your client base processes large or small transaction volumes, this approach exists in order for you to serve as the direct payment provider for your customers. User Experience is a Significant Factor To fully understand the nuances of each partnership approach, each model can be further examined based on a number of interactions between the merchant, ISV, and payment processor. Each of these specific interactions can be used to further define the model. Sales Management, Boarding Experience, Underwriting, Revenue Monetization, Technology Delivery, Risk Management/Regulatory Environment, Service and Support can all have varying characteristics that can further define the approach that best fits an ISVs strategy. The key to understanding the user experience is examining what happens in each scenario and the roles and responsibilities of each party. The idea of who controls the various processes is at the core of the approaches that ISVs take. SALES PROCESS: Sales is a lifeblood to every organization and is the point at which every new client relationship begins. Sales cultures within ISVs differ from organization to organization and beyond selling your core software to your new clients, payments can require further expertise in positioning the features and benefits to prospective clients. Merchants will need to understand ongoing costs, authorization and settlement processes, timing of funds deposits, their support model, technology requirements, and most importantly, how your value proposition compliments their business objectives and goals. Some ISVs understand that payments are not their core competency and wish to outsource this component of the conversation to a trusted partner. Other ISVs look to control the sales experience of their product from the onset and want their sales people to control the entire process, including payments. Finally, some ISVs like to offer a shared sales experience to their prospective customers. The shared sales model allows the ISV to maintain visibility and control of the sales process while still utilizing outside resources and situational expertise. BOARDING: Once the sales process is complete, the merchant must begin a process to implement payments within your platform. Collection of key account information is required on behalf of the client to satisfy fund transmission, tax-reporting requirements, full account underwriting, and compliance checks. Collection of this information can take place a number of ways. Processors are working to move from more of a traditional lengthy paper process to a streamlined electronic or web-based collection method. In other cases, the registration process for creating a merchant account is embedded within the software application, becoming one holistic process. UNDERWRITING AND RISK MANAGEMENT: Payment companies have ongoing financial risk from their clients. When involved directly in the payment ecosystem as an ISO, any time a merchant is unable to fulfill a payment related debt, their payment provider is liable for these financial losses. Therefore, the need to underwrite, or having a clear picture of their clients financial health, is critical in gaining initial insight and then managing this ongoing risk. Payment risk can present itself from a variety of forms. Processors apply a sophisticated formula that takes into account volume processed, size of purchases, whether a card is present or not during a transaction, the likelihood of returns, and the merchant s industry. Financial solvency is a key metric to understand from a balance sheet and income statement perspective. Advanced sales, or pre-sold products or services, have traditionally led to a higher rate of chargebacks (cardholder disputes warranting a refund). Regulatory risk also exists in the form of data security loss exposure and violation of other complex payment card brand rules and regulations. While the roles of underwriting and risk management have traditionally been managed by payment providers, the new age of payments is presenting new options to ISVs. As is common in business, with more risk comes potential greater reward. In other words, the entity that holds the greatest risk has the highest potential upside in a given business transaction. The key to understanding the user experience is examining what happens in each scenario and the roles and responsibilities of each party. 4

5 REVENUE: The reason any business exists is to generate earnings for its shareholders. Therefore, the opportunity to monetize payments is becoming more and more attractive to ISVs. Additionally, the effort to build and maintain a payment interface, introducing clients to a payment processor (referral or ISV sold) and the work to provide payment support to merchants, warrants an additional revenue stream. As is customary, the more roles and responsibilities you takeon, the greater the upside and financial reward. Payment monetization can primarily be structured in two forms: a revenue share model or a buy-rate model. While revenue share offers a split or percentage of the total payment revenue, a buy-rate model shifts the approach to a wholesale/retail model buying your services from a provider at wholesale and assessing your profit margin at the appropriate level to obtain your desired revenue. TECHNOLOGY DELIVERY: When building out or enhancing your payment interface, one of the biggest challenges facing ISVs is staying current on payment gateway features and functionality. ISVs that choose to remain processor agnostic, or providing the ability for your clients to utilize any payment provider, will commonly utilize more standard gateways such as Authorize.net, PayflowPro, or Cybersource. On one end of the spectrum, these ISVs may receive little to no direction and therefore have to embark on research and development of their own payment roadmap. Identifying best practices for protecting sensitive cardholder data, adding emerging payment methods like ApplePay, GooglePay or even Bitcoin, and adapting industry specific complex payment features are left solely up to the ISV. Other models explore a more shared approach to payment product development that is more tailored to the vertical your platform serves. In the world of software development, you can t be everything to all people, so it s important to understand the key objectives and business case of adding payment technology. SERVICE AND SUPPORT: Every organization attempts to develop the best product-suite. However, the inevitable usually happens. Clients will have problems and questions. Beyond the core functionality of your software, payments can provide unique support challenges. Billing questions around fees, allocation of fund deposits, and remittance challenges are potentially regular support discussions to work through with merchants. Many ISVs work hard to develop their brand and create a consistent user experience within their platform. To have a large component of their product outsourced to another vendor doesn t feel right. They prefer to manage all inbound and outbound communication related to the support experience. Other ISVs understand that payments are not and never will be a core competency to their organization. These groups rely heavily on their payment provider to manage their own client relationships and end up having to collaboratively solve problems with their processing partner or an unknown third party vendor. SUMMARY: Now that the key areas of user experiences have been further clarified, it s helpful to revisit the five main models previously discussed to further understand the nuances that make-up each approach. The chart below further looks at each partnership approach and defines the roles for each user experience. Element Agnostic Referral Shared Sales White Label Sales Processor Processor Shared ISV ISV Boarding Processor Processor Processor ISV ISV Underwriting Processor Processor Processor Processor ISV Revenue Technology Delivery Risk Management None Small Share Medium Share Large Share ISO All Share Processor Controls Shared Shared Shared ISV Controls Processor Holds Risk Processor Holds Risk Processor Holds Risk Shared or Alt Risk Options Service & Support Processor Processor Shared ISV ISV ISV Holds Risk 5

6 Factors to Consider When Selecting a Whether you are an ISV that is just starting to think about adding your first payment interface or whether your platform has had payments enabled for many years, it s often a helpful exercise to self-reflect on the key strategic direction of your organization and how payments can complement, enhance, or support that strategy. As the convergence between software and payments continues to evolve, many ISVs are reevaluating their position on the payments spectrum and what approach is best for their organization. A few key factors that could go into your thought process are as follows: What do my customers want and need? Staying market driven is a key idea that businesses should constantly be striving to obtain. Keeping close to existing customers and prospects to understand their key business problems is an essential element in this attempt. These in turn yield innovation and repeatable solutions. A good starting point is taking the pulse on the current ecosystem, or understanding the needs of your customers to accept payments within your application. By having conversations, it s amazing what you will learn. Where is our platform in the product lifecycle? Whether you use an Agile style, Waterfall style, or anything in between for your product development methodology, a product has a certain lifecycle. Sales for a given product are always in either growth, maturity, or decline. It s important to pause and understand where your platform fits on that lifecycle. Many ISVs go to market with the goal of skyrocketing the revenue from their core product. Other ISVs who have previously been to market within their vertical see new revenue starting to flatten. Depending on where you are in the market, adding or monetizing payments may enhance your strategy. What ROI can we expect for adding a new or different payment monetization strategy? Adding payments to your platform is an investment. This process will take development efforts, time to effectively train your employees, and depending on the model you select, hard dollar costs associated with running your own payment program. Whenever you make an investment, the first questions that should follow should be, When can I get my money back? and What will my rate of return be on that investment?. Therefore, it s critical to be able to gain a clear understanding of what revenue you can expect to generate as a result of payments. ISVs should create an internal economic pro forma model to clearly understand what the financial landscape of this project looks like. What is my appetite for risk? Risk is called risk for a reason. It is neither a certainty nor an improbability. While a high-level overview of payment risk was explained, many factors make-up a processors or ISVs risk strategy. Appetite for risk within an organization can typically be defined by culture. It s important when approaching a payment partnership to understand, What risk am I taking?, and to understand what the upside or tangible benefit for taking on additional risk. What types of attributes should I be looking for in a payment partner? Just like when you are buying a car, house, or any other major purchase, it s helpful to have a checklist of items that could help you qualify your partner or purchase in the best manner possible. Here are a few questions to reflect on to help qualify a potential payment provider partner: Is there cultural fit between our two organizations? Do we share the same vision of the product? What is the experience of your partner in the vertical you serve? Is the potential partner bringing new and innovative payment ideas to the table? If my partner is visible to my clients, what will support experience look like? If not, what will our support experience look like? What monetization model is the potential partner providing? Why? Is the strategy clear on how I will receive a return on my investment? What will the impact on our payment monetization be on our clients? Are they still priced competitively within the market? Is my processor offering me API in a box or an implementation plan? What is the plan to update me about emerging trends in the payment industry? How informed are they on data security and the impact to our platform and clients? Is the potential partner asking me to take on payment risk? What could the financial impact potentially look like? 6

7 The current states of the world economy and financial markets are continuing to present new challenges to financial institutions that add complexity to their operations. Best Opportunities For ISVs Given Today s State As discussed, the current state of electronic payments is migrating to a more holistic acquisition model between software companies and payment processors. This white paper has laid out how we arrived at the current state, the main partnership opportunities for ISVs, how to characterize each model or approach and the major factors to consider when evaluating a new payment strategy. The question still exists: Where is the best opportunity for an ISV given today s market? Based on years of payment expertise and operation in the integrated payment space, we see the most promising upside for ISVs to explore the Shared Sales and White-Label models. A number of factors go into this assessment. Primarily, user experience is an element where we see opportunity for dramatic improvement in the market. ISVs that typically leave payments agnostic and don t direct a merchant s buying decision tend to leave a large part of their customers needs ignored. Finger pointing between multiple parties in a fragmented payment industry causes headaches and support issues for merchants that don t have clear direction. By standardizing and controlling the payment environment within your application, clients will have a much more satisfying user experience and end result. Payment monetization is another key aspect directing this position. The majority of ISVs that operate in the current market are under-monetizing payments. While margin compression is a fear on the mind of every business, merchants are willing to pay extra for gained efficiencies and innovative products. Most ISVs are under-positioning the value their solutions bring to the payment process. By not using this leverage, they are leaving revenue on the table. When a business decides to effectively sell a holistic and embedded solution that delivers value to their clients, they are rewarded with greater revenue opportunities. Finally, the regulatory and risk environment cannot be understated. The current states of the world economy and financial markets are continuing to present new challenges to financial institutions that add complexity to their operations. By taking a middle-ground approach within the current environment, ISVs are able to still maintain most of the financial and client facing focused benefits of being a payment provider without taking on the cost, regulatory, and compliance headaches that come with being an owner of your own payment program. 65 Buttonwood Court Madison, WI phone info@windriverfinancial.com WindRiverFinancial.com Member Merchant Services Provider for Synovus Bank